- Date : 12/02/2020
- Read: 4 mins
- Read in : English
Here’s how you can save on tax while taking a loan
A loan is a popular financial instrument that can bridge the gaps in your financial shortcomings. Whether it is to fund your child’s higher education, buy a home, or snag the latest gadget, a loan can help you meet these goals. Various kinds of customised loans are available to suit your needs. A timely loan provides credit, renders tax benefits and in some instances provide a better deployment opportunity for the capital.
Here are some examples of how you can benefit from borrowing money!
Leveraging Opportunity Cost
Most consumer loans today are available at 0% interest cost. Rather than paying upfront for it, you could purchase a new microwave or fancy smartphone through your banks debit/ credit card at a no cost EMI.
If you have the funds available for a gadget that costs say Rs 50,000, you are better off investing that money in a liquid fund or short-term deposit which conversely will pay you back about Rs 3,000 (estimated at 6% return on a short-term income fund), while you take advantage of the interest-free loan.
Debt can be less expensive
Banks and financial institutions are constantly jostling for their fair market share, and the best way to attract customers is to keep the borrowing costs competitive. While this may not entirely be in the control of the financial institution, it presents a good opportunity to recover the cost through smart investment.
In a scenario you need to opt for long-term debt, say for a home loan (estimated at 9%), you can reduce the EMI burden by going for a longer tenure at the same cost. Investing the savings on the EMI in a blue-chip or large-cap mutual fund (earning 12% to 14%) will might provide superior returns and help you earn over and above the cost of borrowing.
Tax benefits on education loans
When you take an education loan from a financial institution for higher studies, you can claim tax benefits on the interest paid under Section 80E of the Income Tax Act. However, the principal amount is not eligible for tax exemption.
You can avail of this tax deduction if you wish to pursue a course after Class 12. You can also claim the tax benefit on education loans for your spouse, children, or any individual for whom you have been appointed as a legal guardian.
Tax benefits on home loans
Home loans are likely to eat into the lion’s share of your monthly income, but also provide maximum tax benefits, as both the principal and interest amount is eligible for tax breaks.
Benefits on car loans and personal loans
A car is perceived as a luxury item, so if you are a salaried person taking an auto loan to buy a car, you may not be eligible for benefits. However, as a self-employed individual, you can claim benefits on the interest as well as depreciation while filing income tax returns.
A similar logic holds true for personal loans. If you avail of a personal loan as a down payment for your home loan or use the proceeds to renovate your house or even to purchase a business asset as a self-employed individual, you can claim a tax deduction of up to Rs 2 lakh as interest paid on the personal loan under Section 24.
As we saw, a loan can help you save money by being smarter with the usage and taking advantage of tax benefits. However, it is advised that you opt for a line of credit only after careful consideration of your repayment capability, and only to the extent needed. Taking a loan beyond your repayment capability could adversely affect your credit score, leading to a potential debt trap.